The recent rise to prominence of SPACs provides private equity portfolio companies an alternative method for stock exchange listing and access to the capital markets.
Special purpose acquisition companies (SPACs) have emerged, somewhat unexpectedly, as the hottest market trend in the US this year, allowing SPAC sponsors to launch shell companies with the goal of taking private companies public via merger. SPACs are rare in Europe due to regulatory constraints — a SPAC acquisition is a deemed reverse takeover, likely to result in the SPAC’s shares being suspended and/or cancelled, with the enlarged group only readmitted following publication of a prospectus.
However, US SPACs offer a direct pathway to the equities markets. With nearly 200 US SPACs seeking a business partner, PE sellers are taking note. We believe these vehicles can offer an attractive exit route for European PE portfolio assets.
SPAC as Monetization Alternative
For PE sellers, taking a portfolio company public by merging it with a SPAC can be a faster, cheaper process compared to a traditional IPO, and can allow the sponsor to preserve upside by retaining shares in the public company, like an IPO. Because the SPAC has already gone through an IPO prior to seeking a merger counterparty, SPAC mergers help avoid market timing issues and the risk of a deal falling down due to volatile conditions — a commonly encountered issue, particularly this year.
A SPAC transaction is generally not a complete exit. In most cases, deals are not structured as full cash-out sales and PE firms are frequently locked up, unable to sell shares for a period post-closing. Even once that period expires, sell downs will be made in accordance with a registration rights agreement, aspects of which are heavily negotiated. Accordingly, PE firms should plan for a structured and longer-term sell down.
However, for portfolio companies seeking growth capital, SPAC sales can be particularly advantageous by allowing them to raise funds via a private investment in public equity (PIPE), in addition to the cash available from the SPAC’s trust account.
Key Attributes for Success
Many traditional investment document concepts such as “Qualified IPO” and “Liquidation Event” do not contemplate the unique structure and considerations associated with going public by combining with a SPAC. It is therefore important that the portfolio company’s financing documents and management equity documents are carefully reviewed to determine how they will operate on an exit via a SPAC IPO.
PE sellers must also ready their portfolio asset for the public markets. While a SPAC may offer a strong valuation, target portfolio companies should take steps to prepare to operate as a listed business. This means ensuring that the right administrative and governance structures are in place (i.e. financial reporting, internal audit, and a general counsel’s office).
As with any exit, PE firms should consider maximising their options by running an auction process. Recent successful auction processes have involved soliciting term sheets and indications of valuation from multiple SPACs, or distributing a letter of intent to which SPACs respond — although sellers should be mindful that the ultimate value of the listed company is frequently determined through the PIPE process, as institutional investors indicate the value at which they are willing to participate. Deal teams should expect a thorough diligence and price discovery process, with both the SPAC counterparty and the PIPE investors.
Deal structure and ongoing governance expectations also require consideration. SPAC sponsors expect some level of board representation, and PE firms should be prepared to consider dual-class shares, shareholder consent rights, and other structures, for the PE firm’s benefit as a majority (or near majority) owner of the public company.
Keeping Up With Innovation
As PE sponsors consider options for monetizing portfolio company investments, going public through a business combination with a SPAC has rapidly become a viable alternative to a traditional IPO, direct listing, or outright sale. As deal terms evolve in this growing sector, sponsors must remain apprised of current market terms and remain nimble to maximise the opportunities available.